Cap Table Primer: How Do I Sell 20% Of My Company 5 Times And Keep Any?

Social entrepreneurs can be parsed along a variety of different axes. One of those is whether the social entrepreneur comes primarily from a business or entrepreneurship background or an impact background without much business experience. This piece is written as a primer on capitalization tables, or cap tables, for those without much business or entrepreneurship experience.

For this piece, I’m drawing principally on my experience running a FINRA-registered boutique investment banking firm that worked primarily with small and midsize companies.

The cap table is the list of owners and their respective stakes in a business and their respective ownership stakes. Generally, entrepreneurs and investors agree that a simple cap table is a better cap table. The fewer the investors the better. When it comes time to make key decisions that require approval from shareholders, the fewer signatures required, the better.

That said, the clutter in a cap table usually comes from a simple need: more money. Investors bring the money entrepreneurs often can’t succeed without.

To optimize your cap table, you will want to be strategic. Start by raising money in rounds rather than in one-off lumps. Rather than negotiate a deal with your uncle one day and a separate deal with your aunt on another, organize a round of friends and family financing and give everyone the same terms. Another key to strategic capital is to take as much capital as you can in each round, so that each will last as long as possible.

At this point, you may be thinking how many rounds will there be? If I sell 20 percent of my company in each of five rounds, does that leave any for me? Isn’t five times 20 percent equal to 100 percent of my company?

It is difficult to know in advance how many rounds of capital will be required, but first time entrepreneurs are often surprised to learn that the big rounds of capital often come after—rather than before—the company becomes profitable. It takes money to grow. When the company is growing, the value is growing. That growth in value effectively makes room for more capital.

Here’s how it works.

Hypothetical capitalization table by round, showing the increase in value. By Devin Thorpe.

For simplicity, let’s assume that you are a single founder that owns 100 percent of the common stock of the company, let’s call it Startup Co. Each time you raise money, you’ll likely issue new preferred shares that will give special rights to the investors, including most importantly the right to get their money out before you get any money out when the business is sold or liquidated. To be clear, you don’t sell any of your common stock. You keep that and issue new preferred shares to the investors.

Sometimes convertible debt structures are used in early rounds to provide similar protections to preferred stock with simpler legal formalities.

Let’s say you do a friends and family round that is what it sounds like, a round of financing from your friends and family. Sometimes these rounds are said to include friends, family and fools as they tend to be so risky. It isn’t really foolishness to invest, especially in social ventures; rather, it is altruism. People want to help you succeed, especially if you have a mission in mind.